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As the crisis in Europe continues to spiral out of control, I wanted to take a look at the cost of insuring against default for the PIIGS (Portugal, Italy, Ireland, Greece, and Spain). As you can see from the chart below, over the past several weeks 5Y CDS for the PIIGS has risen substantially, with the biggest gains coming from the epicenter of the crisis—Greece. Downgrades for both Portugal and Spain with the specter of more to come, have combined with deadly protests in Greece, widening spreads for the PIIGS government bonds over Germany–the European benchmark rate–to record levels. I expect volatility will continue as the situation escalates, with Portugal and Italy being most susceptible to increasingly worried investors, and ratings agencies still under significant scrutiny following the US subprime disaster. Over the short-term, the result of a Spanish 5Y note auction tomorrow should help measure investor sentiment; a successful auction could help stymie, at least for the time being, fears of contagion.

While all eyes remain on Greece, Japan’s fundementals continue to weaken, and in some instances look worse than Greece. There are of course numerous technical and economic differences between the two nations; however, I do not believe Japan’s current deficits and debt load will be sustainable without drastic changes. This is an update from my piece titled ‘Positioning Yourself for Japan’s Potential Demise…’. The charts below illustrate some areas of concers for the Land of the Rising Sun:

EU Commissioner Joaquín Almunia Mira recently said that he believes the current situation is the most difficult situation the EU has ever faced, and that Thursday’s meeting will be critical. He also said EU leaders have indicated that they will support Greece. Fitch anticipates that a Greek plan is ‘achievable’, but not ‘a given’. Fitch’s analyst said, “A bailout for Greece is not completely out of the question but the likelihood of it happening is not strong enough for Fitch to base its ratings outlook on.” Reuters is also indicating that in principle German government officials are ready to help Greece, and along with other CBs and governments are studying support plans. German press is reporting that German officials are working on a support plan for Greece.

Fitch also highlighted that Greece could come under some serious pressure in April/May when the bulk of its debt outstanding is coming due. Fitch also believes the UK is the most vulnerable AAA rated sovereign, stating the credit needs a ’strong exit strategy’. Fitch went on to say that the default probability for Portugal is close to 0.

Contact Me:

Michael.McDonough@fiateconomics.com
Michael is an economist/strategist who has worked from Wall Street to Hong Kong primarily focusing on the U.S. and emerging markets. He has also written several columns. More

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